Gaia Inc (GAIA) 2004 Q4 法說會逐字稿

Welcome to the Gaiam fourth-quarter earnings release conference call. All lines will be in a listen-only mode until the formal question-and-answer session. (OPERATOR INSTRUCTIONS). At the request of Gaiam, today's conference is being recorded. If you have any objections, you may disconnect at this time.

I would like to introduce your speakers on today's call, Mr. Jirka Rysavy, Chairman and Chief Executive Officer of Gaiam, Miss Lynn Powers, President, and Miss Janet Mathews, Chief Financial Officer. Miss Mathews, you may begin.

Thank you. Good afternoon, everyone, and welcome to Gaiam's fourth-quarter and fiscal year 2004 earnings conference call. First, the legalities.

The following constitutes a Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995. Except for the historical information contained herein, the matters discussed in this call are forward-looking statements that involve risks and uncertainties, including, but not limited to general business conditions, the integration of acquisitions, the timely development of new businesses, the impact of competition, and other risks detailed from time to time in the Company's SEC reports. The Company does not undertake any obligation to update forward-looking statements.

I would now like to turn the call over to Jirka Rysavy, Chairman and CEO.

Welcome to our update covering our results for the fourth quarter which ended December 31, 2004. The fourth-quarter results were ahead of our expectations. For the fourth quarter, Gaiam's revenue ended about 3 million above our projection, at 34.8 million compared to 35.1 for the same period of last year.

Gaiam's direct to consumer segment delivered solid internal growth of 14 percent and grew to 54 percent of Gaiam's revenue for the quarter. Gaiam's business segment revenue in the quarter are still 1.6 million lower than in the same period of 2003, primarily due to declining VHS sale and returns of VHS products related to our transition from VHS to DVD.

Gaiam generated positive internal growth for the quarter of 2 percent, reversing two quarters of negative internal growth, despite experiencing high product returns and markdowns associated with the completion of our former transition to DVD.

Revenues for '04 were impacted also by our decision in the beginning of '04 to discontinue a small unprofitable catalog title which had approximately $1 million in revenues in fourth Q of 2003.

VHS return deduction and inventory write-downs also negatively impacted our gross margin, which declined from 50.3 percent in 4Q of '03 to 48.7 in the fourth quarter '04 and 49.7 for the year. Gross margin actually increased or stayed steady by product lines, and margin declined mostly because of product mix and because of our media business, with over 70 percent gross margin was severely affected by our transition from VHS.

With VHS behind us, the gross margin for the next year shall increase to around 51 percent. Primarily as a result of gross margin hits and reserves for all on-hand VHS inventory, we have reported the breakeven quarter on operating line compared to operating profit of 90,000 for Q4 '03. A net loss of 564,000, or 4 cents per share, compared to net income of 341,000, or 2 cents per share in the fourth quarter of 2003.

For the year, revenues were 96.7 million compared to 102 in 2003, a net loss of 4.6 million, or 32 cents per share, compared to a net loss of 9 (indiscernible), or 7 cents per share in 2003.

During 2004, Gaiam generated 3.1 million from its operations and increase its cash position, and as of December 31, 2004, we had 10.4 million, up from 8.4 million in December '03. Depreciation and amortization for the year was 4.9 million compared to a CapEx of 1.6 million. Gaiam still has no debt and unused $15 million line of credit.

The return to positive internal growth in the fourth quarter, despite VHS returns and markdowns which was related to our transition out of VHS format and increasing our gross margin by main product line, as well as the fact that the quarter (indiscernible) be profitable except for VHS impact -- a very good sign for the start of the new year. We expect our internal growth rate to be around 5 percent for the first quarter and between 10 to 12 percent for the year.

Now Janet will give you some more details on the numbers, and then Lynn will give you some business overview. Janet, please.

Thank you, Jirka. Now let me provide some additional details. For the fourth quarter, sales were 34.8 million, or 315,000 lower than prior-year sales of 35.1 million. Gaiam's decrease in revenues was primarily due to a decrease of 1.6 million in revenues generated by the business segment, as Gaiam experienced higher returns and markdowns associated with the format change from VHS to DVD.

Gaiam's direct to consumer segment posted internal growth of 14 percent for the quarter, driven by solid growth in Internet revenue and international revenue grew at 34 percent for the quarter. On an overall basis, Gaiam generated positive internal growth of 2 percent for the quarter, reversing a trend of negative internal growth for the prior two quarters.

Gross profit for the fourth quarter of 2004 was 48.7 percent, down from 50.3 percent for the comparable prior-year period. This was primarily attributable to increased markdowns and costs associated with the transition from VHS to DVD formatted product. These costs included markdowns given to incent sell-through of current VHS inventories and the write-down of certain on-hand VHS inventory, components and packaging.

Total operating expenses decreased to 17 million for the fourth quarter of 2004 as compared to 17.6 million during the fourth quarter of 2003. Selling and operating expense decreased to 14.7 million from 15.2 million in the fourth quarter of 2003. General and administrative expense remained constant at 2.3 million for the fourth quarter of both 2004 and 2003.

The net loss for the fourth quarter of 2004 was 564,000, or 4 cents per share, compared to net income of 341,000, or 2 cents per share during the same period of 2003. For the year ended December 31, 2004, Gaiam's revenues of 96.7 million were 5.2 percent lower than the comparable period in 2003.

Gross profit for the year declined from 52 percent in 2003 to 49.7 percent in 2004, primarily due to a decline in the business segment gross profit from 49.7 percent in 2003 to 45.6 percent in 2004. This decline is primarily due to markdowns, inventory write-offs and valuation reserves, and other expenses we incurred with the changeover from VHS to DVD products. Gross profit by product line has increased, particularly in accessories, but the weighted product revenue mix changed from media to accessories resulted in lower overall margins. With the completion of the format change from VHS to DVD, Gaiam's gross margin should improve to approximately 51 percent in 2005.

Gaiam's operating expenses for 2004 were relatively flat at 54.3 million as compared to 54.4 million in 2003. As a result of lower revenue and gross margin, the operating loss for 2004 was 6.3 million as compared to 1.3 million in 2003. Noncash charges were 5.7 million and 4.4 million for 2004 and 2003, respectively. Net losses for the year ended December 31, 2004 were 4.6 million, or 32 cents per share, compared to a net loss of 972,000, or 7 cents per share for the comparable 2003 period.

Gaiam generated 3.1 million in cash from operations during 2004 and ended 2004 with 10.4 million in cash, up from 8.4 million at December 31, 2003. Gaiam has no debt and an unused credit line of $15 million.

DSO improved to an average of 31 days for the fourth quarter of 2004, as compared to 44 days in Q4 2003. DSO also improved for the year to an average of 44 days for 2004, as compared to an average of 60 days for 2003. Inventory turns for 2004 were 2.9 times as compared to 3 times for the same period in 2003.

Before turning it over to Lynn, I would like to announce our schedule for our next earnings call. The first quarter 2005 earnings will be announced on Tuesday, May 3rd at 4:30 PM Eastern Time or 2:30 PM Mountain Time. Lynn?

Thanks Janet. While we were not satisfied with our annual results, we are pleased that the fourth quarter ended on a positive note with the 2 percent comp reversing our previous two-quarter trend of negative comp. We believe we have weathered the storm in regards to the conversion of formats from VHS to DVD, and are now on track to build back the business to retailer segment.

As compared to 2003, the domestic business to retailers channel declined by 22 percent for the quarter and 26 percent for the year. The balance of our business segments produced solid results for the fourth quarter, with the direct business comp of 14 percent and international business of 34 percent.

During 2004, we experienced a significant shift in our media sales as a result of the industry transition from VHS to DVD. Overall, DVD sales increased; however, it was not enough growth to offset the decline in VHS sales. We have now completed the transition of our stand-alone media library to DVD and have limited VHS production to an as-needed basis.

Our margin for the year declined from 52 percent to 49.7 percent, primarily due to a margin decline in our business to retailer segment. Our product margin in this segment for the year is comparable or improved to last year. However, the overall margin was affected by the VHS decline as we gave markdowns to incent the sell-through of VHS and are treating VHS returns as liquidation inventory.

Also, our margins were affected by our decision to add a DVD component to all kits in stock. Many of our accounts felt having only VHS in our kits was limiting sales and wanted us to add a DVD component for holiday. We added 157,000 DVDs to our existing inventory of kits.

Our business to retailer segment had varied results by channel. We ended the year up in grocery -- including Whole Foods -- Internet retailers, pharmacy, and Target. We had slight declines in book and specialty, with our largest hit coming from non-grocery distributors, Canada and music.

Our mass merchant channel grew at 16 percent for the quarter, recovering from a 6 percent drop for the year. Sales at Target were up 23 percent for the quarter and 3 percent for the year.

The fall reset in Target stores which happened in late third quarter made the most significant impact on the growth of the mass merchant channel. At the end of September 2003, the sporting goods department of all 1300 target stores was reset to include 12 feet of Gaiam branded space. This planogram will be in effect with minor changes until September of 2005.

One of the largest improvements Gaiam achieved was the new planogram with the addition of media into the store-within-store displays. This is the first time that Gaiam media has been in all 1300 Target stores.

In total, net revenue from Target was up 1.3 million for Q4 and 360,000 for the year. As discussed in the third quarter, sales with Target had been negatively affected in Q2 and early Q3 by the markdowns and sell-off of other merchandise to prepare for the reset. All of these costs are being charged as revenue reductions in third and fourth Q. We attended the Target financial meetings this week and are pleased that we outperformed the department and division by over 5 percentage points in revenue growth.

The book channel ended up down 14 percent for the year, reflecting a very large load-in last year for store-within-store at Barnes & Noble. Since the initial placement in Barnes & Noble in 2003, our placement in the stores has moved from premiere introductory placement near the registers to a more in-line position in the stores.

We currently have a Gaiam store-within-store in approximately 120 of the Borders stores. We are continuing the expansion of our store-within-store fixtures to the remaining 350 Borders locations and are expected to have the expansion complete by the end of 2005.

In the grocery channel, sales were up about 140,000, or 27 percent for the quarter, and 255,000, or 12 percent for the year. The addition of the experienced grocery sales manager and the transition to distributor brokers has provided a significant lift in this channel. In addition to stronger service for our existing accounts, distributors have allowed us to reach the smaller natural foods stores.

We recently added almost 200 new doors to our distribution in this channel. We currently have our Healing Arts branded product in testing phase in Albertson's, Giant Eagle, Kroger and Safeway. We recently work with United Supermarkets and Pharmaca stores to transition to exclusively Gaiam products for their mind body assortments.

Sales to sporting goods retailers were down about 240,000, or 26 percent, for the fourth quarter. We were affected in this channel by the Dick's/Galyan's merger with the decline in Galyan's business for the quarter. REI continued to do well with our products and posted positive comps of 8 percent.

Our new sporting goods sales team has initiated grass-roots efforts in this channel and is proposing the expansion of the Gaiam fit line for ways to advance the product offerings in this market. We're also working to differentiate the product offerings from the mass and specialty retailers by developing new core products to be sold in this market in 2005.

In the fourth quarter our business with the clubs was up almost 60 percent from a flat season overall. In first Q 2005, Best Buy launched the opening of their newest retail concept called Eq-Life. The driving concept behind the store, which is located in Minneapolis, is to offer a single-stop shopping location for health, wellness and complementary technology products to help balance and enhance the quality of life. As part of their product assortment, Eq-Life selected Gaiam as their exclusive provider for mind body fitness products. They are carrying all SKUs in our current assortment. The recent sell-through reports were very positive for Gaiam products.

As we discussed in the third quarter, we began some new product initiatives with Amazon.com and doubled the business in both the third and fourth quarters. Our net sales to Amazon.com ended up 78 percent for the year. We will continue to take advantage of what we learn from this account and utilize their strengths to help us continue to grow our media business in both online and retail sectors.

Our music business declined by over 450,000 in 2004 as we made the decision to discontinue our third-party distribution agreement and launch our own music line in 2005. We hired a music rep last month and are looking forward to launching our Gaiam sound solutions in early 2005. We tested a few of these titles at Eq-Life and had good sell-throughs.

As we discussed before, we're taking our sales of soft good products to a more grass-roots approach. During the fourth quarter we launched our first Gaiam store-within-store for organic soft goods set in ABC Carpet and Home, a premier retailer in downtown Manhattan. Sell-through has been good and we are now working on the product assortment and planogram for the next set. As part of the display, we'll be including some of the images from our organic cotton project in India.

In addition, last weekend was the setup for the new Whole Foods premier location in Austin which will carry a fuller range of Gaiam products, including our soft goods. Members of Gaiam's merchandising and sales team headed to Austin to merchandise the products and set the space. This will be another excellent branding opportunity for Gaiam.

In 2005, we'll be testing special promotions with Hilton Gardens Hotels and Jenny Craig Weight Loss Centers featuring our media and accessories. These types of programs will help expand our customer reach and work to supplement service industries that are not part of our typical distribution networks.

Our Canadian business declined by 655,000 for the fourth quarter and 1.6 million for the year. This is the final quarter on our current distribution contract. We are renegotiating this contract currently. As in the U.S., our distributor also needed to work through VHS returns and price reductions on DVD.

Our retail distribution in the UK has increased with the introduction of fashion yoga props and accessories. POWERbreathe, which is a technical fitness product that was purchased by our UK team, is now ready for distribution in the U.S. The product is testing very well in our catalogs and was launched to our trade business at the supershow last month in Orlando. POWERbreathe is a final contender for the new product for the year award in sporting goods.

Gaiam products were featured in last night's Oscar bags for the third year in a row. Last year Gaiam products were requested by Julia Roberts, Tom Cruise, Robin Williams and Susan Sarandon, just to name a few. We are excited about the opportunity for branding for Gaiam with this incredible placement.

We're also in the process of editing an infomercial featuring Mariel Hemingway and Rodney Yee. We believe there is a tremendous opportunity for Gaiam media and products in transactional marketing. We have screened the preliminary cut and have had good response from our test group.

Our media won 16 Telly Awards in 2004, bringing our total to 37 Tellies. We also won three Kid's First awards and 12 Aegis Awards. In 2005, we will begin prominently displaying our awards on our media packaging. We were also named as the best yoga DVD and best pilates DVD in Self Magazine last month.

Our media is broadcast on Discovery, Fit TV and Fine Living. We're in the process of negotiating to double the number of programs currently being aired.

The direct business had a solid fourth quarter with 14 percent comps fueled by strong Internet sales. We implemented several new programs on the Internet, including Easy Ask and catalog shopping online that helped facilitate converting more customers to online shoppers. Our e-mail campaigns grew at 34 percent and our affiliates at 53 percent during fourth Q. We believe there's real opportunity for growth in this channel in 2005. We will also be launching our Gaiam store on Amazon.com in early April.

The direct business for full year 2004 had a 7.7 percent comp increase. In addition, there was a decrease in overall consolidated net revenue of 2.5 million for the year due to the non circulation of one of our smallest catalogs.

The Gaiam best customer program is gaining momentum and was expanded to 18,000 customers near the end of the holiday season. For the year, independent Web marketing programs continued to exceed our expectations. Revenues from Web affiliates were up 47 percent over 2003, e-mail campaigns up 12 percent, and search engine placement up over 17 percent.

Our operational staffs in the direct business for the quarter were excellent. Fill rate was at 94 percent against last year's 90 percent, and fill rate for the full year was at 94 percent, as compared to 2003 at 91 percent. Our average order size grew to $108 for the catalog for the quarter versus 106 for last year, and the Web was $88 versus $87 last year.

We ended the year with the average order size in catalog up over $3 and over $1 on the Web.

Although 2004 was a difficult transition year for Gaiam, we're feeling upbeat and confident for 2005. We are through the transitions from VHS to DVD, including adding the DVD component to all kits. We've taken the necessary inventory write-downs on VHS and marked down the store inventory. We completed our move from a third-party distribution to our own distribution center in Cincinnati. We are in the process of finalizing contracts for our Canadian distribution to get that business back on track. Our direct business remains solid and our online business is growing rapidly. We expect Gaiam will benefit from the growing trend of consumers seeking advice and experiences on health and sustainability.

I would now like to open the call for questions.

(OPERATOR INSTRUCTIONS). Mark Rupe, Adams Harkness.

Just a couple of quick questions. For next year, correct me if I am wrong -- you said 5 percent growth in Q1, and then 10 to 12 for the year?

Yes.

Any idea what Target represents of that? Is there any kind of color you can provide on that?

Target represents about 12 percent of our business overall.

As far as the growth next year, is Target driving a bigger portion of it, or is it going to be across the board?

No, it's across the board.

You said it goes through September of '05. Is that just a formality, or will there be a serious discussion on where the relationship goes forward from there?

That's just a formality, Mark.

We hope to expand additional media at that point.

On Borders, did you say that you were increasing your store-within-a-store concept by a couple of hundred this year?

That's correct. We're in about 120 right now and they are expanding to all doors, and they have about 450 doors.

Obviously, the topline growth is obviously a positive after last year. Any idea on what your thoughts are on how much you can leverage to the bottom line for next year, just kind of a sense?

There is, obviously, the main things to grow, topline and media, because media has much better (indiscernible). It's really a question of which kind of product mix or which kind of business line grows. But, obviously, with the VHS hit this year it's the main thing. We have -- our goal would be actually to increase something on the second and third quarter especially, spending more aggressively the infomercial which probably would take some of the upside from the P&L, especially in the second quarter by doing the infomercial. But should really benefit in fourth quarter pretty heavy. And because the response was so positive and media is so key to us -- so (indiscernible) will be a lot of focus to kind of get more media through, even if we have to up-front some of the expenses because the topline growing which we probably see from second quarter pretty hefty growth. We would not kind of put at least in the second quarter, maybe part of it in the third, preload some expenses on the media buys for the televisions which will see the benefit in the third and mostly fourth quarter.

And on the DSOs, obviously they came down pretty significantly here. Do you think they'll be kind of sustained at this level or is there more room to go there?

I think we are about as low as we're going to go, Mark. We're getting a lot of pressure for extended terms from our retailers.

For us it's probably more focused. These last two years we focused more on receivables, because if we grow the business fast it's going to get (indiscernible) and control is more important there. I think for us is more right now focus on inventory. I think we have room to take some cash from inventory. (indiscernible) planning to decrease some of the SKUs especially in direct business and take some cash out of it (indiscernible) as well.

Any CapEx in '05 kind of similar to what we have seen in '04?

Pretty similar.

Jeffrey Eli (ph), River City Investments (ph).

What's happening internationally? Have you got any bright spots, new stuff going in UK, Asia Continental Europe? How are you going to be working that?

Internationally right now in the UK, as you saw, we had a great quarter with the 34 percent comp. We are also working right now to expand our presence in Asia through distribution agreements in Japan and Korea and sell-through is -- and Australia. Sell-through is great.

What about South America?

We have nothing planned for that at this point in time.

For us internationally, it's not quite a big focus because we have so much (indiscernible) right now getting through the VHS in the U.S. (indiscernible) pretty much a significant part. The Australia launch is very encouraging. We have a partnership there with no real money at risk with the largest (indiscernible) company there, and first launch did pretty well. And the rest is pretty much licensing. We take no risk, it's just additional revenues through our mostly media titles.

But you're not putting any money as far as (indiscernible) promotion in that area that at all?

No. It's all funded by the outside partners.

Did you -- most of it -- you attributed your drop in earnings almost entirely to the VHS transfer to DVD. Did you have any pressure from competition? Do you recognize any competition out there, anything serious? And what is your strategy, if there is any?

I think it was more industry transition. We kind of forced it through this year because we -- frankly, we didn't have a good year to start with. We kind of wanted to have it all behind us. And the VHS still continue out there probably (indiscernible) be out first and second quarter later. But we kind of wanted to get out there and get it out of the VHS inventory. And because we have extra revenue in the quarter, we kind of wrote those VHS off and we can't liquidate them. We would probably kind of go more and donate them to the school to protect the brand.

So you're not feeling any competition? There's nobody identified as causing a lack of growth or slowdown in growth?

I don't think it's competition-related at all.

Eva Martin (ph), EDP (ph).

I'm just wondering, has the demand for kids’ yoga fitness products been softening? Because I noticed that your products -- your kids’ yoga products are not in Target anymore.

Target decided to do their own private label on the kids, and we're also launching in April of this year our Scooby Doo Do Yoga line with Warner Bros. So, we've replaced the (indiscernible) kids with the Scooby Doo line and we'll be launching that in the book channel and sporting goods and some grocery in second Q.

Josh Harvey (ph), Advanced Global Marketing.

What new product lines or specific new products are you working on to remain competitive?

The main product I see in the sporting goods as Lynn mentioned the POWERbreathe. It's right now selling about 22 countries and start (indiscernible) very well.

What is POWERbreathe?

It's a technical device used to actually work the lung muscles.

It's a respiratory training device that is used by a number of elite athletes, and people can benefit that have asthma and other respiratory ailments. And also we're rolling it out to the general public as a breathing device that will help in your general life.

It was pretty hot in the Gaiam Olympics -- in Athens Olympics, and a lot of people use it -- British team, Australians. And the price point will be probably around 50 to $70. So, as we brought in the U.S. BalanceBall years ago, and it's still probably our best seller, so this is something to replace, like, the BalanceBall and the -- not replace, but add to the BalanceBall some sporting -- same kind of chains from Target to (inaudible)

And as I mentioned before, it's also being -- right now it's a contender for final best product of the year in the whole sporting goods channel.

It sounds very interesting. What segments are you seeing as the growth segments, and which ones are downtrending -- yoga, pilates, media, clothing, energy, home-based products, personal care, etcetera?

The main thing hopefully that will grow for us this year is media. DVD already increased for us in the first Q. The scanning results are quite encouraging. We have the video scan positioning almost double our market share on overall video, and probably we jump (indiscernible) 4 points in fitness video. So it's probably hopefully our best line, because it carries over 70 percent gross profit. That's what we want to focus on because (indiscernible) the DVD changed that's where we lost the ground. So we need to really push that, and nothing close can match the results.

Do you have any research in terms of yoga going up and down, or how is this research on market trends done?

Our new lines are (indiscernible) which is really kind of yoga with martial arts.

We've gone into -- recently in the media side gone into more of the Tai Chi, Chi Gong and this Budokon, which is martial arts with yoga. And that has been launched using a lot of celebrity endorsements, including Courtney Cox and Rene Russo.

How is the research on market trends done?

We have a counsel of about 2000 people online, so if you ask the questions we typically get them in four hours, and then we work with same lines everyone else would work in this way. But the customer counsel is very, very helpful for us. And, obviously, the best results are the catalog. We put in the catalog and we see if it's selling, because we have 16 million catalogs out there. So it's probably the quickest research on a mass scale we can do.

What's interesting about our panel, we have -- like Jirka said, it's almost up to 4000 now customers who volunteered to be on our panel. We put out questionnaires and the last one that we put out we had a 60 percent response rate in about 48 hours. So it's been great research for us.

Dan Moorefield (ph), Wellington Partners.

I might have missed this earlier on the numbers, Janet, but what was the breakdown of the 2004 loss with the direct -- the business segment and direct to consumer?

The direct to consumer segment -- the operating loss was 82,000 versus 6.2 in B to B in the business segment.

So, pretty much if you take the VHS and all its impacts around and -- the direct business didn't really suffer. It was mostly B to B segment -- sorry -- the consumer segment was not actually a loss, if you kind of (indiscernible) it all came from domestic business to business segments. Pretty much driven most of it through the (indiscernible)

So, how does the business to business segment loss compare with 2003?

In 2003 the loss in the business segment was 1.9 million.

And in 2004 -- what was the total?

6.2 million in the business segment.

That's, obviously, a large swing. And you're attributing that primarily to DVD?

The majority of it, yes.

To VHS. The markdown of the VHS and the transition out of that format. Up until 2004, most of our accounts carried both VHS and DVD inventory. Media is a complete return guaranteed sale industry. So, when they decided when the accounts -- we were very proactive in doing this -- decided to get out of VHS, we took the returns or incented markdowns through the sell-through at the store.

So you understand the scope of it, because the VHS will carry some very mid-70s gross profit. In '03 was still about 40 percent of our sales came from media -- from VHS, and suddenly those (indiscernible) went to negative. So not only do you don't have the positive sales with 70 percent margin but you have those sales basically taking it back. And not only do you need to liquidate inventory, but you're basically taking 70-plus percent gross profit through your P&L, which was recognized in previous years. So it's a very massive transition.

So for the first quarter, the business to business segment is looking at being profitable with the DVD trends (indiscernible) being down?

We would consider it probably a breakeven quarter for us in the first quarter, and growing from there.

I guess I'm just --

There are still a couple -- we took some back (indiscernible) people also (indiscernible) we pushed them out in the first Q. We still have some cleanups with (indiscernible) VHS. But for DVD changed the lines, getting through different titles and all that stuff. So will still affect us a little bit in the first Q. That's why we said first quarter only 5 percent gross and 10 to 12 after that internal.

Just looking at the last two years as a whole and aside from the DVD transfer, is there any other line items that are really damaging the business segment? And what other changes, aside from the DVD switchover, are going to make the business segment more profitable?

I think one of the things is just a focus on our top 25 accounts. We went out into certain accounts that we have pulled back from and taken returns, such as Kohl's, who was discounting our brand below map, so we pulled out of that account. And we had gone into some accounts that we just really don't want to be in in the future. So, focusing on our top 25 accounts and growing the business with those accounts I think will also be a much better way for us to go.

Increasing our store-in-stores which increased another 500 doors right now. So, that's really kind of more focused and growing the number of doors. However, we'll still probably grow doors and (indiscernible) and we kind of replace some of those like Lynn mentioned when we started to have a conflict between Target and Kohl's mainly. And obviously, with Target (indiscernible) important customers, we clearly decided to support that.

The movement into the grocery segment and other mass merchants is not going to minimize or water down the branding power in stores like Target, making you (indiscernible) that market?

In traditional grocery we're going in under the Healing Arts brand.

(indiscernible) In Wal-Mart and Sam's. So, nobody except Target (indiscernible) get our brand from the mass market.

Except for media. Of course Gaiam media is sold as all media is sold across channels.

People at Wal-Mart -- that's only what we would sell to Wal-Mart to start. We won't sell anything to Wal-Mart in media.

In connection with your positive growth, I think you said 14 (ph) percent in the consumer business. Aside from developing the Internet, what other strategies are you working on to improve those rates (technical difficulty) sales?

On the catalog side we're really focusing on our Gaiam best customers program and creating community with them and touching them more often. So, that is our growth strategies, along with the Internet. And the Internet we think we can grow a lot this year. I'm particularly excited about Gaiam's store being on Amazon.com in early April.

The overall shift in our strategy from what used to be like transactional marketing to kind of relationship marketing, so there's more like repeat buys and subscription kind of products as a part of the mix. So, repeat buy kind of increased.

With the printed catalogs, are they quarterly distribution across all the different brands, or is it semiannually?

It's monthly depending on the catalog brand. Certain catalogs are monthly, others are more like quarterly.

It's heavily skewed to the fourth quarter, obviously. Same as Internet.

With the catalog, we noticed in the past that you had a magazine type catalog that was available. I think there was one or two editions. What happened with that?

New edition of the (indiscernible) will be in April.

So you actually -- that'll be something separate to the print catalog?

Yes. The megalogs we do like (indiscernible) years or something, something like that -- infrequently. It's kind of an overall summary of the Gaiam things. It's more promoting the Gaiam message than it's actually a revenue generator.

And you said April for another release of that?

Yes, that's correct. Mid April.

So would that be edition number two or three? How long have you been doing it for?

We had the first one in the beginning of '01, and then we did like '03. So it's every two years pretty much.

And the megalog you're seeing more as a relationship building rather than a revenue generator?

Yes. Our catalogues are pretty much mailed, and if they pay directly by the sales from the book -- so you measure square inch. Megalogs are kind of overall story promotions that will go to all the -- go to (indiscernible) but mostly to accounts, commercial accounts, and when we want to tell Gaiam's story rather than it's kind of a book to sell from directly.

It's more information.

The typical catalog would have between 60 and 90 pages. Megalog would probably have 180 to 200.

Bret Miley (ph), Rutabega Capital.

I was wondering if you could tell me to begin with how many -- you've got to think about 3500 store within stores as of -- I think -- or at least the beginning of '04. How many will you have going, I guess, at the end of '04 and how many in '05?

The 3700, that's from our -- I think when we took last time. So it's -- we currently have about 4200.

4200.

(multiple speakers) grew about 500 since we -- for last quarter.

And we know in second quarter we'll be growing about 300 in Borders.

And that's what you've discussed so far?

Yes.

I wanted to also get a little bit of history. How long have you guys been in Target? Forgive the basic question, but just curious as to -- the earlier questioner had asked a little bit about the private-label. And obviously target is really good at private-label. And I'm just curious as to how long you have been dealing with them, and kind of whether you think that is a threat in other products, or whether this is kind of a one-off?

We have been dealing with them since -- well, since about '97 in the media. And really started expanding with them in 2001. And then of course this past year we grew from 4 feet to 12 feet. And they really believe in the Gaiam brand. And as far as Target is concerned, we are the premier brand for mind body health for them, and they certainly let us know that by the presentation, the positioning in all the stores. I think on the children's side, I just think they felt they wanted to do private-label on that for margin.

Just for you -- we have our board member who built the brand called Cherokee. And he target us about 2 billion of his (indiscernible) brand right now. And we just had discussion on the board how far and how (indiscernible) he should grow his target. And his (indiscernible) was 200 million (indiscernible) have no problems there.

That would be a good problem to have. On the infomercial side, have you guys done these before? You mentioned that you guys were doing one -- I guess this was -- is that the Budokon or is that a different one?

This is a different one. This is called Yoga Now and it's featuring Mariel Hemingway and Rodney Yee.

Have you guys done this before, and what is the production cost of this? I guess I'm just trying to figure out was this something new or whether it's something you've had experience with in the past.

We don't have meaningful experience. We kind of tried to test it before, but we really hired a team this time which the producer on it is the guy who produced a show called 24.

24 Hours.

24 Hours. So the producer of that is the producer of our infomercial. And people who (indiscernible) infomercial same company (indiscernible) pilate (multiple speakers)

The director did Windsor pilate. So, we hired a real professional infomercial team to do this.

Have you guys quantified how much that will cost in terms of dollars out of pocket?

It's all upside (indiscernible). I think out of the pocket it's about 500,000.

That's correct.

Okay. That's production cost. And then you'll have to pay for the media time, correct?

Everybody else -- not (indiscernible) the people like the guy, the 24-hour producer and Mariel Hemingway -- they're just splitting the upside as a share (indiscernible) not taking anything (multiple speakers)

A question for you on the club business. I think in '03 you guys had mentioned one of the reasons your revenue went down was you had a big cost co-promotion that I think didn't repeat. Does that tend to be a promotion-driven business? I think you mentioned you had a good quarter this past fourth quarter. How should I think about that business?

I think you should think about it as a seasonal or occasion business. And what we've been doing with the clubs recently is just it used to be really a fourth quarter business, and now we're going out with promotions for Mother's Day and back to school and holiday. So I think we'll be more of a year-round business and not so weighted to the fourth quarter.

(multiple speakers) think this year because of the infomercial (multiple speakers)

We'll also have it in fourth quarter.

Because you're already spending the top money in the second quarter primarily in third have benefit (indiscernible) especially earnings will be heavily skewed for fourth quarter.

I understand. A question on the Canadian distributor. You've got the contract rolling over. Obviously it's not been a particularly -- it's been weakening somewhat. I don't know whether that was all VHS to DVD transition. Is that something where you're actually -- are you still interested in working with the same group, or are you trying to maybe switch them out? I'm just trying to figure out how that relationship is going?

We are interested to work with the same group but change a little bit the way how it was done. So, however, you know, with the VHS DVD (indiscernible) experience here, it's hard to blame them. And part of the -- they had one promo (indiscernible) in Canada year before, so that's kind of local worst from that point of view, because especially the mass -- especially like Costco -- you -- sometimes they do big promos; sometimes they don't. So, but yes it would be interesting to work with the same people assuming we can have a reasonable contract going forward.

And on the Budokon, you mentioned that's kind of the newest -- the products that have probably got the most pop for it maybe next year. How does that typically get advertised? Do you guys spend on that, is that something where -- how will you promote that?

We're actually doing both. We're getting a lot of public relations on it. And in Us Magazine and Fitness, and I believe Self Magazine -- because of the star power with Courtney Cox and Jennifer Aniston actually doing the programming. And then we do a little bit of advertising on it as well.

It sounds like just to quote -- and then I'll get off the line, but I appreciate all the info. On the DVD to VHS transition, it sounds like -- are you guys fully reserved for that at this point? You mentioned it sounds like it's going to still continue in some other liquidation phase in the first and second quarter. Are you -- (indiscernible) reserve fully taken or is that still going to hit us in the first half of the next year.

We're fully reserved taking this (indiscernible) inventory to zero reserve, so we could basically not. We still have most of it, some of it which (indiscernible) mentioned (indiscernible) to school, because we have (indiscernible) expected in fourth Q. But yes, we kind of reserved. We still are (indiscernible) what do we have total? Maybe 30,000 right now out in Target, Lynn.

Yes. We have still some units out there at retail in grocery and in Target (multiple speakers)

(multiple speakers) so, you know, it's very small. Because some of the people like Target when I carry one or two titles I think it's just (indiscernible) down (indiscernible) total below 50,000 (indiscernible) out there probably.

I would say it's below 50,000 between Target and grocery, yes.

Sorry. I had one other. On the Internet, what percent of your business is affiliates versus from your own side?

(indiscernible) have the number here. We don't.

Is it vastly bigger for the affiliates? Can you give me just an idea of magnitude?

No. The biggest drivers are actually catalogs, because catalog (indiscernible) these same catalog people (indiscernible) Internet. It's far away the biggest (indiscernible) that's really what (indiscernible) driver for Internet.

Josh Harvey, Advanced Global Marketing.

I just had a quick question on a personal note. I'm a big shopper at Whole Foods and I'm curious -- two questions. What role of importance does Whole Foods play in overall percentage of business these days?

Whole Foods is not really (indiscernible) it's not really that important (indiscernible) because simply they don't have enough doors from their revenues, but from the relationship it's very important to us because we test with them most of the new stuff. They're very progressive. We really like them. (indiscernible) going right now to open a new store with like 80,000 feet.

Square feet in Austin, yes.

So we're taking much bigger space and we really kind of like what we do. But, obviously, because from overall number of doors it's not that big change. So from revenues it's not that important to us. But from a relationship and exposure to new stuff it's (inaudible) --

And from the same target demographic.

Don't they have some kind of -- aren't they somewhat of a partner in Gaiam or some kind of invested interest.

Yes.

Third and finally, just on a local note. I'm being told by my favorite Whole Foods store that they are caring less of Gaiam because they feel the threat of Target carrying it.

That's not what the numbers show. Maybe on a particularly -- a one-store issue. But our numbers are up with Whole Foods.

It's eventually because Whole Foods is kind of store by store. It's not like -- like with Target, we sell them -- all the stores will carry the same -- Whole Foods is another case. It's really (indiscernible) centralized so each store manager can pick whatever they want. And if they have a Target next to them, it might be the issue, but (indiscernible)

I could understand their concern being compared -- having to be compared or compete with Target must be tough.

We were in Target before we were in Whole Foods.

(OPERATOR INSTRUCTIONS). At this time we have no further questions.

Thank you very much. Thanks for your participation and we will talk to you hopefully on our next quarterly call. Thank you very much.